Correcting Failed Conversion
For a 2009 conversion, should MAGI exceed the $100K limit, we would prefer to correct the failed conversion by simply withdrawing the converted funds from the Roth IRA rather than recharacterize back to the IRA as we expect low tax rates to apply this year. Is my undertanding correct that withdrawal of the converted funds from the Roth IRA prior to filing of the 2009 tax return will correct the failed conversion, and are there any nuances to the process that we need to be aware of to ensure we avoid any penalties?
Your input / comments are appreciated.
Permalink Submitted by Alan Spross on Tue, 2009-12-22 04:57
You apparently want to be taxed on any failed conversion as an IRA distribution rather than recharacterizing, if I understand your plan. You can do that if you wish or could recharacterize part and be taxed on the rest. What you need to do:
1) The 6% excise tax will be due if you do not remove the converted amount by the extended due date
2) You would report the distribution in your taxable income on line 15 of Form 1040 just as you would had you converted.
3) If you were under 59.5 when the TIRA distribution was taken and do not qualify for another exception, the 10% early withdrawal penalty would apply.
4) If you remove the Roth contribution prior to the extended due date, an earnings calculation must be done for the period of time the Roth held the conversion. Any earnings would also have to be withdrawn and would be taxable and subject to penalty as above. You would request this distribution as a corrective distribution of an excess contribution, and the Roth custodian will code it as such. You do not have to report it on Form 8606. The Roth distribution will be tax free except for any earnings since you will have paid the tax on the original TIRA distribution.
If you do not want to take out the earnings, just recharacterize the conversion and then take a distribution of the amount you want. The earnings would stay in your TIRA. If the IRA custodians are the same, they should be able to handle it this way in the same time as a recharacterization.
Permalink Submitted by Andrea Cohen on Tue, 2009-12-22 05:49
Thanks Alan, that is what we are planning — client is older and we have opportunity to capture some IRA distribution at low tax rate this year. Ideally we’d like to transfer to the Roth, but if unable we’d still like to have distribution taxed in 2009. I very much appreciate the explanation of the process to follow, and have one follow up question regarding your last point. If we were to recharacterize the conversion and then take out amount we want, would that push the taxation of the distribution from 2009 to 2010 or would the taxable event still be in 2009? Thank you again.
Permalink Submitted by Alan Spross on Tue, 2009-12-22 20:25
It would only be taxable in 2009 if the custodian could process the post recharacterization distribution before year end. Perhaps you could request or even offer to pay a fee for expedited handling, but a discussion of the options with the custodian would be wise at this point. For some custodians this would not be a problem, and for others it might take a special effort.
Permalink Submitted by [email protected] on Mon, 2009-12-28 22:45
[quote=”[email protected]“]It would only be taxable in 2009 if the custodian could process the post recharacterization distribution before year end. Perhaps you could request or even offer to pay a fee for expedited handling, but a discussion of the options with the custodian would be wise at this point. For some custodians this would not be a problem, and for others it might take a special effort.[/quote]
Hi Alan, I have run into a similiar situation with a client that has ordinary income losses that they want to offset with a conversion or distribution in 2009 and I wanted to clarify the point you are making.
If the conversion fails the $100k MAGI test in 2009 and you end up doing the recharacterization in 2010 is there anyway to have the post recharacterization distribution count for the 2009 tax year? Based off my reading of your last reply it seems you can only recharacterize and get the distribution to qualify for 2009 only if both are completed in 2009.
Thanks for the clarification…Richard